Question
The ILC Company (ILC) is considering a capital restructuring to allow $500 million in debt. Currently, ILC is an all-equity firm with earnings before interest
The ILC Company (ILC) is considering a capital restructuring to allow $500 million in debt. Currently, ILC is an all-equity firm with earnings before interest and taxes (EBIT) of $380 million. Assume unlevered firms in the same industry have betas of 0.90. You can assume this would be the beta for ILC too (ILC is also unlevered). Assume the market risk premium is 7% and the risk-free interest rate is 5%. Assume that the corporate tax rate is 35%. You may assume that all earnings are paid out as dividends, and that any future debt will be used to buy stock back. For simplicity, assume that cash flows are perpetual, and debt is perpetual.
a. How would the proposed restructuring change the value of ILC as a whole? (Hint: You may not need to compute the new cost of capital to find the new firm value.)
b. If ILC was considering issuing $2 billion in debt instead of $500 million, would the methodology you used in the previous question be equally appropriate? Why or why not? Please limit your answer to 3 sentences or less.
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